Regulators Defend Madoff Oversight

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Regulators Defend Madoff Oversight

Published: January 27, 2009
WASHINGTON (Reuters) — Top federal regulators defended their oversight of securities markets on Tuesday and said they had investigated Bernard L. Madoff’s brokerage firm in the past but found no evidence of a vast fraud.

The Securities and Exchange Commission is being heavily criticized for not thoroughly following up on tips from one of Mr. Madoff’s competitors and missing red flags like Mr. Madoff’s ability to generate steady returns in all types of market environments.

The industry-financed Financial Industry Regulatory Authority (Finra) has also been tainted by the Madoff scandal, as its main mission is to supervise nearly 5,000 brokerages.

At a Congressional hearing, the S.E.C.’s head of enforcement, Linda Thomsen, said the agency started an investigation of Mr. Madoff’s business in 2006 but closed it early in 2008 without recommending enforcement action.

Ms. Thomsen also said that the S.E.C. filed two enforcement actions in 1992 that involved Mr. Madoff’s broker-dealer firm, but that neither Mr. Madoff nor his firm was named as a defendant in either case.

Lori Richards, the S.E.C.’s director of compliance, inspections and examinations, said the S.E.C. did examine Mr. Madoff’s broker-dealer operation — most recently in 2004 and 2005 — but found no fraud.

The S.E.C. did not examine Mr. Madoff’s advisory operations although the firm registered as an investment adviser in September 2006, Ms. Richards told the Senate Banking Committee in prepared testimony.

The banking committee pressed top enforcement officials on how and why they failed to uncover Mr. Madoff’s alleged $50 billion fraud.

“The fact that the regulators were put on notice through direct tips, press articles and industry chatter raises serious questions about the state of our regulatory system,” said the panel’s top Republican, Richard C. Shelby of Alabama.

The Senate Banking Committee chairman, Christopher J. Dodd, said the Madoff fraud was a regulatory failure of historic proportions. “But what’s more disturbing about it is that it went undetected until the perpetrator himself confessed,” said Mr. Dodd, a Connecticut Democrat.

Finra’s interim chief executive, Stephen Luparello, said the watchdog conducted regular examinations of Mr. Madoff’s broker-dealer operations during the last 20 years.

Finra received and investigated 19 complaints against Mr. Madoff’s broker-dealer, but the complaints generally related to trade execution quality and did not relate to the investment advisory issues where fraud was alleged, the watchdog has said.

Mr. Luparello said the watchdog never received any complaints charging a Ponzi scheme, nor did the S.E.C. share tips or concerns with Finra.

The top securities regulators suggested ways to improve their oversight, including more coordination between the S.E.C. and Finra, third-party custody of customer assets and aligning broker-dealer rules with investment adviser regulations.

Regulators also suggested that auditors for broker-dealers needed more oversight.

Mr. Dodd expressed disbelief that the S.E.C. did not zero in on the fact that Mr. Madoff’s auditor was a tiny, little-known auditor. “Isn’t it often a preliminary question to ask, who is your auditor?” said Mr. Dodd.

Ms. Thomsen said consideration needed to be given to imposing requirements about an auditor’s qualifications.

Other experts have said broker-dealer auditors should be required to register with the audit supervisor, the Public Company Accounting Oversight Board.

Ms. Thomsen of the S.E.C. said resources for the agency had not kept pace with the growth in the securities industry and said the agency simply did not have the resources to fully investigate every tip.

Ms. Richards, the S.E.C.’s top compliance official, said the agency was considering the frequency of its examination of investment advisers and was determining if advisers should disclose more risk-related information, like the identity of their auditors and their performance returns.